Trump is Wrong About Free Trade

Last Friday, President Donald Trump spoke at the Boeing assembly plant in South Carolina and said, “our goal as a nation must be to rely less on imports and more on products made here in the US”. As Kevin Williamson of the National Review put it, “this is, to use the technical term, stupid”. This is a perfect example of the economic illiterate protectionism Donald Trump ran on. Protectionism flies in the face of what every student in an introduction to macroeconomics class is thought. Many of his supporters will try and argue he really is not a protectionist but that he is actually referring to making business more competitive through regulation and tax reform but you have to really read into him to get that statement and ignore his explicit praise of protectionism in his inauguration address.

Let me start with critical a mistake the Trump team makes in this discussion before moving back to Trump’s statements. The Trump team is under the assumption that trade deficits shrink Gross Domestic Product or GRP (calculated by adding consumption, investment, government spending and net exports). The basic argument goes like this because GDP is calculated by adding net exports. That means that imports subtract from GDP meaning they make the economy smaller. While they are technically right about imports technically subtracting from GDP they ignore why. GDP is Gross Domestic Product and as its name implies it is about domestic production. Imports are counted when you purchase them in consumption but since they aren’t produced domestically they need to be subtracted via net exports meaning that the effect is neutral.

The great irony of Donald Trump’s point of view is that US manufacturing output is at historic highs.A lesser irony comes from Trump’s Boeing speech. While the plane Trump is standing in front of is assembled in the United States its construction is completely reliant on foreign trade. This is not just an anomaly for Boeing but a standard story throughout the whole US economy. Over half of imports are used in American production. This is not a glitch but a huge benefit. Of course, I can already perceive the protectionist argument saying “but what if we produced X in America instead of in Z then we would be able to add Y billion to the economy so we lose potential gains.” This is a simplistic view that ignores comparative advantages. Goods are being produced in other countries because they have a comparative advantage. This means that they are cheaper at it than we are, meaning that we can buy the same amount of goods for less so we can either buy more of that good or buy something else that we wouldn’t be able to afford otherwise.

Think of it this way. You have a trade deficit with your local grocery store but no one would think this is bad. Your grocery store has a comparative advantage compared to you when it comes to food. Sure you could growth your own food but it would cost far too much time, money. The same idea applies to international trade. The goods other countries produce lets us focus on goods we are better at allowing us to have more than we could otherwise. The graph below democrats this principle. Known as a production possibilities frontier it shows how much you can produce in a simple bilateral model (yes this is simplified from the complexities of international trade but the complexities of international trade can not be put on a graph). To explain the graph simply, the curve represents all the possible productions and is maximum efficiency without trade. It is impossible for production to be beyond the curve without trade but as point “e” shows, production with trade makes it possible. Allows for more to be produced than is possible without trade.

Donald Trump’s views on trade are not just contrary to basic economics but also to the economic consensus and empirical evidence. The Chicago University IMG forum of leading economists found overwhelming results. Not one economist disagreed with the statement that “freer trade improves productive efficiency and offers consumers better choices, and in the long run these gains are much larger than any effects on employment.” The same overwhelming result held when economists were asked if “on average, citizens of the U.S. have been better off with the North American Free Trade Agreement than they would have been if the trade rules for the U.S., Canada, and Mexico prior to NAFTA had remained in place.” For a full assortment of studies demolishing the protectionist prison see here and here but I will highlight a few. A World Bank study found that “…there are only two major cross-country empirical studies that look at the impact of trade policy on unemployment rates. One is [a] paper by Dutt, Mitra, and Ranjan (2009) and the other is [a paper] by Felbermayr, Prat and Schmerer (2011). Both papers show that countries that have less protectionist (more open) trade policies have lower unemployment rates.” A 2013 meta-analysis from the Czech national bank reviewing 60 studies found, “strong positive effects on long-run growth” even after correcting for bias and misrepresenting evidence.